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Id like to talk about an important theme I’ve been mulling over recently, and is related to two new PodClips I recorded over the weekend, which can be listened to at the bottom of my commentary.
Markets are crashing and correcting right now and everybody’s talking about stocks getting revalued to adjust for the new environment, but that doesn’t necessarily mean that you need to panic sell out of your favorite stocks that might be going through a rough patch. In the first clip, I talk about a process of examining the staying power of your current portfolio and how to find new opportunities in the current market environment.
“Look for high quality companies already making adjustments to their businesses. And that way, you might be able to prevent yourself from panic selling a great company, where the situation may correct in the short to medium term. It may even present some interesting buying opportunities during the environment.”
In the second clip, I talk about how to think about valuing stocks in the new environment
“You want to go back and look at what the earnings power of the company was before this crisis occurred. Especially if it’s profitable. You can say “okay, well, the stock is selling at 20 bucks now, and has a P/E of 25 or something. But what if it’s a P/E of 10 on the previous earnings run rate?”
What all this means is that you can use this time to reevaluate your portfolios. Identify the weaker companies where the new environment is going to hurt them in the long term. Maybe they were not ever profitable in the first place, and the new environment is going to make it even harder for them to reach that goal. These are some considerations you have to heed.
So, how do you really identify the stocks that are getting crushed in the current market – the ones to fish for and might be ideal candidates to add to your portfolio?
I’ve started getting more aggressive trying to find opportunities in stocks that are adjusting to the current inflationary environment, giving me a great pipeline of stocks to share with you as I continue my research.
y approach would be to look for companies that are giving out indications that they’ve taken measures to be able to start growing revenues and earnings again, once their market segments begin to normalize. Also, there might be cases where companies have already adjusted to the new environment and don’t have to wait for the situation to normalize so they can grow again.
If you start looking at companies that are already putting pricing increases in place to counteract inflationary pressures on gross margins, you’ll see that some of those price increases haven’t yet been deployed over their entire sales cycle or sales chain. Pay attention to that on conference call transcripts and press releases. Once the price increases play catch-up, you could see a return to growth in sales and earnings.
However, something to keep in mind is that the price increases may not account for all of the inflation related rise in the cost-of-goods-sold expense line, so make sure you pay close attention to management’s commentary on that subject.
You’d also want to pay attention to any kind of changes companies make to their cost structure. It is normal for companies to spend too much when they have been in a nice growth phase for many years, but in times of crisis survival mode kicks in and companies have to look at where they can cut some unnecessary fat. These are the companies that may still be able to grow revenue and profitability even if the inflationary environment worsens.
This is how you’ll be able to avoid panic selling a great stock as the situation may stabilize in the short to medium term.
Companies have been reporting their financials during these volatile times and we are starting to get an idea of companies that have actually made changes to their business environment to account for inflation and we now know what their model would look like in the long term as we wait for the market to normalize.
Therefore, you want to look at a company’s earnings capacity before this crisis occurred, especially if they’re profitable. That way, you might find nice bargains at normalized P/E ratios that might look higher right now. For example, let’s say a stock is selling at $20 now and has a P/E of 25. But what if it’s selling at a P/E of 10 on the pre-crisis run rate of earnings?
Some of the best situations are when you see companies that have implemented cost cutting initiatives, trading right now on really low P/Es based on earnings that probably will increase substantially, beyond their historical run rate, when the business environment improves.
I am compiling a tabulation to sort out P/E ratios, price to sales ratios, based on current EPS numbers and on normalized pre-crisis conditions, that I will soon make public for you.
PodClip – Which Companies To Hang Onto During Market Volatility, Part 1
PodClip – Which Companies To Hang Onto During Market Volatility, Part 2
~ Maj Soueidan, Co-founder, GeoInvesting
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